Patriot to buy Interstate Hotels for $2.1 billion

CBS.MarketWatch.com

DALLAS (CBS.MW) -- In its largest acquisition to date, Patriot American Hospitality Inc
PAH, -0.87%
. said Tuesday it will buy Interstate Hotels
IHC, +0.49%
for $2.1 billion in cash, stock and debt.

The merger gives Patriot ownership of 40 hotels and control over an additional 182 through leases and service agreements. The transaction valued Interstate shares at $37.50, or about 75 cents above their closing price on Monday.

Investors weren't impressed. Interstate, one of the largest owners of luxury independent hotels and resorts in the lodging industry, fell 13/16 to 35 15/16. Patriot shares closed down 3/4 at 30 13/16.

The deal comes on the heels of several Patriot acquisitions, notably its pending deals to buy Wyndham Hotel Corp
WYN, +0.73%
. and WHG Hotels & Casinos
WHG, -0.28%
. Combined, just those three deals give Patriot a hotel portfolio of 455 properties with approximately 103,000 rooms, including 156-owned hotels and resorts, representing more than 40,000 rooms.

The growth will also give Patriot a $7 billion market capitalization to fuel further growth. "I don't think they're through yet," said Sands Brothers & Co. analyst Brad Cohen. "I think they're going to continue to grow through a combination of internal growth and selective, opportunistic purchases of single assets as well as portfolios."

With the $1.1 billion Wyndham Hotel merger in April, Patriot became the largest U.S. hotel Real Estate Investment Trust.

Desirable markets"I would expect this transaction to provide us yet a broader foundation upon which to build our world-class hotel company"

Patriot Chairman Paul Nussbaum "This transaction includes our acquisition of an exceptional portfolio of 40 hotels in geographically desirable markets, many of which are candidates for conversion to the Wyndham brand," said Paul A. Nussbaum, Patriot's chairman and chief executive officer.

"I would expect this transaction to provide us yet a broader foundation upon which to build our world-class hotel company," he said.

In connection with Patriot's agreement to acquire Interstate, Patriot and Marriott International
MAR, +0.02%
announced they've signed a non-binding letter of intent allowing Patriot American to end franchise agreements on 10 Marriott hotels owned and operated by Interstate, and to convert these hotels to the Wyndham brand. In return, Patriot will allow Marriott to assume management of 10 franchised Marriott hotels.

Cash, stock, debt

Under terms of the acquisition, 40 percent of Interstate's outstanding shares will be converted into $37.50 per share in cash. The remaining 60 percent of Interstate's shares will be converted into $37.50 in Patriot paired shares under an exchange ratio. If the Patriot Average Price is below $26.42, Interstate will have the right to terminate the merger under certain circumstances, the company said.

Patriot said it is assuming $785 million in Interstate debt as part of the transaction.

Tom Parrington will continue as president and chief executive officer of Interstate Hotels, which will become a division of the paired operating company, soon to be renamed Wyndham International. He also will assume the position of vice chairman of Wyndham International following the Interstate acquisition.

REIT power

Like Starwood's recent multi-billion bid for lodging giant ITT, which awaits shareholder approval, the Patriot deal on Tuesday reminded the industry of the emerging power of REITs.

REITs are fast becoming the preferred way for investors to take large positions in owning American real estate. Under law, REITs are required to pay out 95 percent of their income to shareholders, which often allows them to provide liquidity in a market where there traditionally has not been much, analysts said.

But the REITs have roused increasing opposition from the traditional lodging companies. Because REITs are exempt from paying corporate income tax, hotel owners claim they are enjoying an unfair tax advantage.

Parrington said that Interstate was attracted to the idea of a REIT in particular as a partner in the industry. "We felt the paired share structure gave us tremendous advantage to raise capital."

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